November 02, 2006

 

What will the "Trust-Tax" announcement affect exactly? Oh, just the economy...

From: The Wall Street Journal

Canada Tax Move Hits Shares
Key Index Falls 2.4% on Bid To Impose Levies on Income Trusts
By MARK HEINZL

November 2, 2006; Page C12

TORONTO -- Canada's S&P/TSX composite stock index sank 2.4%, as investors fled income trusts in the wake of the government's unexpected announcement that it plans to put an end to the tax advantages of the popular investment vehicles - a move that riled many in the country's financial community.

Income trusts involved in businesses from oil and gas to pet food and pizza chains saw unit holders bail out of their securities. The S&P/TSX Canadian Income Trust index plunged 12.4% amid the frenzied trading. The broader composite index fell 294.20 points to 12050.39.

After the Canadian stock market closed Tuesday, Canadian Finance Minister Jim Flaherty blindsided investors by announcing plans to tax income trusts in line with corporations, though he said Ottawa would allow a four-year grace period for existing trusts. The Conservative government, elected earlier this year, had pledged to avoid adding taxes to trusts during its election campaign.

Canadian income trusts currently pay little or no tax and they distribute much of their profits to unitholders. As a result, most provide higher payouts than other publicly traded companies, with yields ranging anywhere from 4% to 15% or even higher. The attractive yields and favorable taxation treatment for foreign investors also have made Canadian income trusts popular among U.S. investors.

The Canadian government's move was "a total stunner," especially since trusts were "a winning political issue for the Conservatives," said Chip Hanlon, president of Delta Global Advisors Inc., Huntington Beach, Calif., which advises a Claymore Securities fund holding Canadian energy trusts.

"This was right out of the blue...it's a total flip-flop," said Sandy McIntyre, senior portfolio manager with Toronto-based Sentry Select Capital Corp., which manages 3.5 billion Canadian dollars (US$3.11 billion) of income-trust assets. The Canadian government "misled and really adversely affected the retail investor, many of whom are very dependent on the trust income they receive to make day-to-day ends meet."

Some tax experts and politicians have been crticizing the trust structure since it encourages business to pay their income out to investors rather than reinvest in equipment, technology or other assets that generate future growth.

Mr. Flaherty, the finance minister, said the tax measures are needed "to restore balance and fairness to Canada's tax system, to ensure our economy continues to grow and prosper and to bring Canada in line with other jurisdictions." With companies increasingly converting to trusts to skirt tax obligations, Canada's tax burden was shifting too much to "hardworking individuals and families." If the trend were left unchecked, the government stood to lose billions of dollars of revenue, he said. In order to mitigate the trust-tax hit to older Canadians, Mr. Flaherty also announced tax breaks for pensioners and seniors.

About 250 Canadian companies have converted to trusts, most in the last few years, commanding a combined market value of about C$230 billion. Over the past year, however, dozens of trusts found their payouts were unsustainable and were forced to slash their distributions, which sent their unit prices nosediving even before yesterday's bloodbath.

Among the big, widely held trusts that sank sharply yesterday were Canadian Oil Sands Trust, down C$3.01, or 9.9%, to C$27.41; Penn West Energy Trust, down C$6.09, or 14.4%, to C$36.12, and Yellow Pages Income Fund, down C$2.86, or 18.9%, to C$12.26.

"The erosion of market capitalization observed in the marketplace today resulting from this decision far outweighs any tax leakage, real or perceived," and has "effectively raised the Canada risk premium," said Richard Fortin, vice president of Stonebridge Advisors LLC, a Wilton, Conn., investment firm that specializes in Canadian income trusts.

The timing of the tax measures appears aimed at heading off the planned conversions to trusts of two of Canada's biggest companies. Telus Corp., Vancouver, British Columbia, and Montreal-based BCE Inc., both telecommunications companies, recently announced plans to turn themselves into trusts and pay out a substantial part of their income to investors. Those moves won applause from investors and sent Telus's shares, in particular, sharply higher. Yesterday, Telus shares gave back much of those gains, sinking 13.5% to C$56.15. BCE shares dropped 11.4% to C$28.10.

Some fund managers argued the trust selloff was overdone. "We're in there buying," said Sentry Select's Mr. McIntyre. He said some trusts now yield as much as 20% or more and, if their distributions are maintained, an investor would receive most of her capital back before the tax measures go into effect in 2011.

Copyright 2006 - The Wall Street Journal

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